Morgan Stanley: Fed Reaction Function Comes Under Scrutiny - FJElite

Last week showed that central bank decisions and market reactions do not always move together. The Fed, Bank of England and Bank of Japan all left policy unchanged, but the Fed produced the strongest response. Three dissents in favour of a hike showed how close the Committee may be to tightening, while markets had priced around a one-third chance of a move.

The press conference triggered the bigger reaction, with short-term yields falling and longer-dated Treasuries selling off. Breakevens widened, the dollar weakened and risk assets came under pressure as investors reassessed how the new Chair intends to return inflation to target. Although subsequent core PCE data confirmed that inflation is softening, markets remain uncertain about the Fed’s reaction function and have not fully accepted that further hikes are off the table.